Question

ASSIGNMENT 3- 60 MARKS

1. 1. (a) Briefly define interest rate and explain the types of interest rate. 10 Marks

1. (b) Jim deposits $3,000 today into an account that pays 10% per year, and follows it up with three more deposits at the end of each of the next 3 years. Each subsequent deposit is $2,000 higher than the previous one. How much money will Jim have accumulated in his account by the end of 3 years? 10 Marks

1. 2. (a) John wants to make sure that he has saved up enough money prior to the year in which his daughter begins college. Based on current estimates, he figures that college expenses will amount to $40,000 per year for 4 years (ignoring any inflation or tuition increases during the 4 years of college). How much money will John need to have accumulated in an account that earns 7% per year, just prior to the year that his daughter starts college? 10 Marks

  

1. (b) Jim needs to borrow $50,000 for a business expansion project. His bank agrees to lend him the money over a 5-year term at an APR of 9% and will accept either annual, quarterly, or monthly payments with no change in the quoted APR. Calculate the periodic payment under each alternative and compare the total amount paid each year under each option. 10 Marks

1. 3. (a) Joshua, who is currently 25 years old, wants to invest money into a retirement fund so as to have $2,000,000 saved up when he retires at age 65. If he can earn 12% per year in an equity fund, calculate the amount of money he would have to invest in equal annual amounts and alternatively, in equal monthly amounts starting at the end of the current year or month respectively. 10 Marks

1. (b) Kay has just taken out a $200,000, 30-year, 5%, mortgage. She has heard from friends that if she increases the size of her monthly payment by one-twelfth of the monthly payment, she will be able to pay off the loan much earlier and save a bundle on interest costs. She is not convinced. Use the necessary calculations to help convince her that this is in fact true. 10 Marks

Answer 1

Q-1)

a) Interest rate is the rate that is charged by the lender to borrower for lending him the funds. The interest rate set the rate at which the required rate or discount rate of project will be valued to determine whether the project is acceptable or not. Interest rate is a concept which is closely related to the concept of time value of money, it compensates for future value. There are basically two types of interest rates, real interest rate and nominal interest rate.

· Real interest rate is the rate which is adjusted for the inflation rate, real rate is exclusive of inflation rate. For example, if the nominal rate is 12% and inflation during that period is 5% so the approximate real rate would be around 12% - 5% = 7%.

· Nominal rate is the rate where inflation is inclusive, inflation is added in the real rate to achieve the nominal rate. Let’s say the real rate of interest is 7% and inflation rate is 5%, then nominal rate would be approximately 12%.